Agreed. Also don’t want to have multiple single factor funds where one fund might be buying a stock and another fund selling the same stock. For example a momentum fund might be selling a stock that is going down. A value fund might want to purchase the same stock as it enters its buy range. Better to avoid trading costs and put the factors into one fund. Better to have a single fund that owns stocks ranking B in both categories than single factor funds that will own A stocks for one category that get D grade in the other.km91 wrote: ↑Thu Sep 22, 2022 3:17 pmThe FF factor model describes stock returns as a linear combination (weighted average) of the factor loadings and return premiums. Each factor independently describes some dimension of stock returns and as a whole any given portfolio can be described as a combination of the factors. The larger the tilt away from the MKT premium and towards the other factors, the more diversified the portfolio should become.abc132 wrote: ↑Thu Sep 22, 2022 2:38 pm I was thinking about the independence of factors and wondering why there would be any products suggested that were combinations of factors.
For example, X% (small minus big) and Y% (value minus growth) should be a much better way to invest than SCV. The former makes it easy to maintain factor weightings and the latter makes it impossible.
The only thing I can come up with is we may say factors are independent but we invest as if they are not independent - chasing the combination that worked well recently.
The profitability + small post in this thread is a good example of what I am questioning, along with lots of comments (in general in the last few years) that you just need the right combination of factors. All of these seem to speak of factors not actually being independent.
Which is it?
I think it would be practically impossible to create a portfolio with a loading of 100% to value and 0% to any other factor, even in a long short construction. The factor model tells us returns are driven by a combination of the factors. We are not concerned about isolating any single factor, but rather creating a portfolio that has less of its return driven by MKT and more of the return driven by alternative factors